The starting place for analyzing a company is typically the balance sheet. Think of the balance sheet as a photo of the business at a specific point in time. It presents the assets, liabilities, and equity ownership of a company as of a specific date.

• Assets are the economic resources controlled by the company.
• Liabilities are the financial obligations that the company must fulfill in the future. Liabilities are typically fulfilled by payment of cash. They represent the source of financing provided to the company by the creditors.
• Equity ownership is the owner's investments and the total earnings retained from the commencement of the company. Equity represents the source of financing provided to the company by the owners.

The balance sheet provides users, such as creditors and investors, with information regarding the sources of finance available for projects and infrastructure. At the same time, it normally provides information about the future earnings capacity of a company's assets as well as an indication of cash flow implicit in the receivables and inventories.

The balance sheet has many limitations, especially relating to the measurement of assets and liabilities. The lack of timely recognition of liabilities and, sometimes, assets, coupled with historical costs as opposed to fair value accounting for all items on the balance sheet, implies that the financial analyst must make numerous adjustments to determine the economic net worth of the company.

The analyst must understand the components, structure, and format of the balance sheet in order to evaluate the liquidity, solvency, and overall financial position of a company.

Balance Sheet Format

Balance sheet accounts are classified so that similar items are grouped together to arrive at significant subtotals. Furthermore, the material is arranged so that important relationships are shown.

The table below indicates the general format of balance sheet presentation:

This format is referred to as the account format, which follows the pattern of the traditional general ledger accounts, with assets at the left and liabilities and equity at the right of a central dividing line. A report format balance sheet lists assets, liabilities, and equity in a single column.

Balance Sheet Components

Current Assets

These are cash and other assets expected to be converted into cash, sold, or consumed either in one year or in the operating cycle, whichever is longer. The operating cycle is the average time between the acquisition of materials and supplies and the realization of cash through sales of the product for which the materials and supplies were acquired. The cycle operates from cash through inventory, production, and receivables back to cash. Where there are several operating cycles within one year, the one-year period is used. If the operating cycle is more than one year, the longer period is used.

Long-Term Investments

Often referred to simply as investments, these are to be held for many years and are not acquired with the intention of disposing of them in the near future.

• Investments in securities such as bonds, common stock, or long-term notes that management does not intend to sell within one year.
• Investments in tangible fixed assets not currently used in operations, such as land held for speculation.
• Investments set aside in special funds, such as a sinking fund, pension fund, or plant expansion fund. The cash surrender value of life insurance is included here.
• Investments in non-consolidated subsidiaries or affiliated companies.

Property, Plant, and Equipment

These are properties of a durable nature used in the regular operations of the business. With the exception of land, most assets are either depreciable (such as a building) or consumable.

Intangible Assets

These lack physical substance and usually have a high degree of uncertainty concerning their future benefits. They include patents, copyrights, franchises, goodwill, trademarks, trade names, secret processes, and organization costs.

Other Assets

These vary widely in practice. Examples include deferred charges (long-term pre-paid expenses), non-current receivables, intangible assets, assets in special funds, and advances to subsidiaries.

Current Liabilities

These are obligations that are reasonably expected to be liquidated either through the use of current assets or the creation of other current liabilities within one year or within the operating cycle, whichever is longer.

The excess of total current assets over total current liabilities is referred to as working capital. It represents the net amount of a company's relatively liquid resources; that is, it is the liquid buffer, or margin of safety, available to meet the financial demands of the operating cycle.

Long-Term Liabilities

These are obligations that are not reasonably expected to be liquidated within the normal operating cycle but instead at some date beyond that time. Bonds payable, notes payable, deferred income taxes, lease obligations, and pension obligations are the most common long-term liabilities. Generally they are of three types:

• Obligations arising from specific financing situations, such as issuance of bonds, long-term lease obligations, and long-term notes payable.
• Obligations arising from the ordinary operations of the enterprise, such as pension obligations and deferred income tax liabilities.
• Obligations that are dependent upon the occurrence or non-occurrence of one or more future events to confirm the amount payable, or the payee, or the date payable, such as services or product warranties and other contingencies.

Owner's Equity

The complexity of capital stock agreements and the various restrictions on residual equity imposed by state corporation laws, liability agreements, and boards of directors make the owner's equity section one of the most difficult sections to prepare and understand. This section is usually divided into three parts:

• Capital stock: the par or stated value of the shares issued.
• Additional paid-in capital: the excess of amounts paid in over the par or stated value.
• Retained earnings: the corporation's undistributed earnings.

Practice Question 1

Current assets are cash and other assets expected to be converted into cash, sold, or consumed either in one year or in the operating cycle, ______

A. whichever is longer.
B. whichever the company wishes to.
C. One year is the maximum time period for current assets' expected life cycle.

Correct Answer: A

Current assets are cash and other assets expected to be converted into cash, sold, or consumed either in one year or in the operating cycle, whichever is longer.

Practice Question 2

Current assets are presented in the balance sheet in order of ______.

Correct Answer: liquidity

Practice Question 3

On the balance sheet, the amount that is "net assets" is equivalent to the amount shown as "owners' equity." True or False?

Correct Answer: True

Remember the accounting equation: assets minus liabilities equals owners' equity. "Net assets" and "owners' equity" on any given balance sheet are equal amounts.

Practice Question 4

Etown Bakery provides the following information from its accrual-basis financial statements:

Year 2015 Salaries Expense $100,000
12/31/2014 Salaries Payable $9,000
12/31/2015 Salaries Payable $12,000

How much cash did the bakery pay out for salaries during 2015?

A. $12,000
B. $103,000
C. $97,000

Correct Answer: C

An increase in a liability (salaries payable) results in a decrease in cash outflow. Cash outflow for salaries equals $100,000 accrual expense less the $3,000 increase in salaries payable. Ending salaries payable = Opening salaries payable + Salaries expense - cash (12,000 = 9,000 + 100,000 - X)

Practice Question 5

The recognition of liabilities often results in ______.

I. the recognition of expenses
II. a more conservative representation of financial position
III. a decrease in net income
IV. a decrease in ROI

Correct Answer: I, II, III and IV

Practice Question 6

Each of the following should be classified as plant and equipment on the balance sheet of Chin's Nursery except ______.

A. the office building or a new machine
B. land on which the nursery is located
C. plants held for resale to customers

Correct Answer: C

Practice Question 7

Expenditures capitalized as noncurrent assets generally include those expenditures that are ______.

A. made for normal repairs to maintain the usefulness of the asset over a number of years
B. for items that have a physical life of more than a year, regardless of their cost
C. material and that have an economic benefit to the entity only in the current year
D. material and that have an economic benefit to the entity that extends beyond the current year
E. immaterial

Correct Answer: D

Practice Question 8

Long-lived assets refer to ______.

A. assets that are held by a company for more than one year
B. tangible fixed assets including plant and machinery
C. resources that are used to provide services to a company and are not bought with the intention of resale

Correct Answer: C

Long-lived assets are used by the productive or administrative sides of a company to support the company's business but are not bought for resale; these include tangible and intangible assets. They do not include items such as inventory, although inventory could also be held long-term.

Practice Question 9

If a company holds a stock that is closely held (not publicly traded) and there is no market or a limited market at best for the stock, how should the company classify this investment?

Correct Answer: Long-term investment

Practice Question 10

What should an investment in common stock be categorized as on a balance sheet?

A. Long-term investments
B. Either current assets or long-term investments
C. Neither current assets nor long-term investments

Correct Answer: B

It depends on whether management's intent is to hold this stock for the long-term or short-term.

Practice Question 11

Crashem Co. purchases equipment for $180,000 in cash. How would this transaction affect its financial statements?

A. It would increase fixed assets and decrease cash on the balance sheet; It would be cash outflow from investing activities on the statement of cash flows.
B. It would increase expense on the income statement and increase fixed assets on the balance sheet; It would be cash outflow from operations on the statement of cash flows.
C. It would increase fixed assets and increase long-term debt on the balance sheet; It would be cash outflow from operations on the statement of cash flows.

Correct Answer: A

Practice Question 12

Which of the following is (are) not (a) current liability (liabilities) as of Dec. 31, 2015?

I. Management fees collected in advance in 2015, to be earned during 2016
II. The portion of long-term debt due in 2016
III. Warranty liability for products carrying a two-year warranty sold during 2015
IV. The interest due to creditors and bond holders for 2016, to be paid in 2016

A. I and III
B. II only
C. IV only

Correct Answer: C

Practice Question 13

Which of the following statement(s) is (are) true?

I. Estimated liabilities have two basic characteristics: the liability is known to exist and precise dollar amount can be determined.
II. An accrued liability is an accrued expense.
III. Unearned fees and customer deposits are examples of unearned revenues.
IV. Working capital is a more stringent measure of solvency than the quick ratio.

A. I, II and III
B. II and III
C. III and IV

Correct Answer: B

I. The two basic characteristics are: the liability is known to exist and the precise dollar amount cannot be determined until a later date.

II. When a liability is accrued (recognized before its due date), an offsetting expense (accrued expense) is recorded.

III. Unearned fees and customer deposits are unearned revenues, which are usually classified as current liabilities.

IV. Working capital (current assets-current liabilities) measures uncommitted liquid assets. The quick ratio (the most liquid assets/current liabilities) is a more stringent measurement of solvency.

Practice Question 14

How are unearned revenues classified on the balance sheet?

A. Current assets
B. Current liabilities
C. Other revenues

Correct Answer: B

Since unearned revenues involve activities related to the business's normal operating cycle, they are classified as current liabilities. Unearned revenues represent an obligation to perform a service or to return money to a customer.

Practice Question 15

BB Corporation's trial balance included the following account balances on December 31, 2015:

Accounts payable: $90,000
Bonds payable, due 2016: $150,000
Discount on bonds payable: $18,000
Dividends payable: $48,000
Notes payable, due 2019: $120,000

What amount should be included in the current liability section of the balance sheet?

A. $270,000
B. $306,000
C. $390,000

Correct Answer: A

All items due in the next 12 months should be included (accounts payable plus, bonds due 2016, less related discount, plus dividends payable).

Practice Question 16

On September 1, 2016, OGR Company issued a note payable to National Bank in the amount of $225,000, bearing interest at 12% per annum, and payable in 3 equal annual principal payments of $75,000 plus interest. The first payment for interest and principal was made on September 1, 2017. What amount of accrued interest payable should OGR record on December 31, 2017?

A. $5,500
B. $6,000
C. $9,000

Correct Answer: B

It would be necessary to accrue for September, October, November, and December. ($150,000 x 0.12 x 4 /12) = $6,000

Practice Question 17

Which of the following is (are) long-term asset?

I. An idle building
II. Land held by land developers or subdividers

A. I only
B. Both of them
C. Neither of them

Correct Answer: C

I is an investment. II is inventory.

Practice Question 18

A long-term asset is different from a prepaid expense primarily because a long-term asset ______

A. has physical substance.
B. is long-term in nature.
C. is used in operations and not for resale.

Correct Answer: B

This is the most correct statement. The primary difference between long-term assets and current assets in general is their useful lives.

Practice Question 19

A long-term asset is different from a long-term investment in stocks or subsidiaries primarily because a long-term asset ______

A. is used in operations and not for resale.
B. has physical substance.
C. is long-term in nature.

Correct Answer: A

The most correct statement is A. The primary difference between long-term assets and long-term investments in general is use in the operations of the business.

Practice Question 20

A long-term asset is different from inventory primarily because a long-term asset ______.

A. is used in operations and not for resale.
B. has physical substance.
C. is long-term in nature.

Correct Answer: A

The most correct statement is A.

Practice Question 21

When credit is granted to a company by its suppliers and employees, the balance sheet classification is called ______.

A. short-term debt
B. current portion of long-term debt
C. operating and trade liabilities

Correct Answer: C

Operating and trade liabilities, and advances from customers, are consequences of operating activities.

Practice Question 22

Select the correct statement(s):

I. Under the cash-basis method, warranty costs are charged to expenses as they are paid.
II. The current ratio is intended to indicate the long-run liquidity position of the firm.

A. I only
B. II only
C. Neither is correct

Correct Answer: A

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Practice Question 23

Assume U.S. GAAP. The following information is available from the accounting records of a company as of 31 December 2016 (all figures in $ thousands):

Accounts payable: 20
Accounts receivable: 82
Bank loan, due on demand: 44
Cash: 12
Income taxes payable: 5
Inventory: 47
Investments accounted for by the equity method: 112
Loan payable, due 30 June 30 2018: 50
Deposits from customers for deliveries in 2017: 8

The working capital for the company (in $ thousands) is closest to:

A. 48
B. 64
C. 72

Correct Answer: B

Current Assets: Cash 12 + Accounts receivable 82 + Inventory 47 = 141

Current Liabilities: Bank loan, due on demand 44 + Accounts payable 20 + Income taxes payable 5 + Deposits from customers for deliveries in 2013 8 = 77

Working capital (CA - CL): 64.0

Practice Question 24

Under IFRS, a bank, or other financial institution would normally use which type of balance sheet format?

A. Classified
B. Liquidity-based
C. Market-value based

Correct Answer: B

Under IAS No. 1, liquidity-based presentation is recommended when it provides information that is more relevant and reliable than the current/noncurrent format, such as in the case of banks and financial institutions.